COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL AND THE EUROPEAN CENTRAL BANK Responding to challenges for critical financial market infrastructures and further developing the Capital Markets Union
1. The financial crisis highlighted deficiencies within the over-the-counter (OTC) derivatives markets which traditionally have been an opaque part of financial markets, traded bilaterally between firms rather than over exchanges. In particular, the financial crisis highlighted the following two deficiencies:
a. Counterparty credit risk – the web of relationships in the OTC market means the risk of default of a major market participant can have systemic implications. AIG highlighted weaknesses in the management of counterparty risk, when a credit downgrade required AIG to post collateral it could not afford.
b. Transparency – the financial crisis (e.g. the failure of Lehman Brothers) demonstrated that market participants and regulators did not have sufficient visibility of exposures in the OTC market, making it difficult for regulators to monitor risks arising from derivatives exposures and causing unwillingness to trade in stressed markets.